For the traders that look at the various trading instruments and wonder what should learn to trade first I put together this blog to explain why I trade option and why you should also consider Options in your portfolio. Nowadays the volume of options traded has exploded and I foresee a time when option trading will pass the stock trading volume. There are now a multitude of options on various trading instruments with very liquid options that can even be used for day-trading. For reference in addition to stocks options there are index options, ETF options, and futures options that can be traded.
But first what is an option? Below is the definition that may sound intimidating if you are hearing these terms the first time, however no need to be alarmed. At The Trader Institute we are very much oriented towards the beginner traders and we provide education in options in addition to the other trading instruments.
Firs let me give you the definition of an option: in few words it a standardized contract transacted between two parties. The contract offers the holder (buyer) the right, but not the obligation, to buy (for call options) or sell (for put options) a security at an agreed-upon price (strike price) during a certain period of time or on a specific date (called the exercise date).
When you hold a Call you have the option to buy at certain price, therefore you want the security to go up above the strike price by time of the expiration of the contract. The opposite is true for put options, the holder of the put option wants the price to go down below the strike so he can profit from the fact that he is selling above the current market price.
It may take a little while to fully internalize what this mean but at TTI we like to practice a lot to be absolutely sure the concepts are fully understood.
Now let’s go forward to see some of the key reasons I trade options:
1. Flexibility: options allows me to configure a trade that achieves different goals, this is because we ca buy and sell both calls and puts and we can combine them various ways. If you get a little bit deeper into trading options you will start hearing things such as “vertical spreads”, “iron condors”, “butterflies”... and a zoo of name that have been used to make these trade easy to remember. In the beginning all these things are not needed but as you get more advanced you will be start using some of the more complex option strategies.
2. You can achieve high levels of leverage with a defined downside risk. This is both important to the trader with small account but also to the large account owner that wants to take advantage of a significant market move without using his entire account.
3. You can define your risk upfront by the specific strategy you use. This is key if you have a small account and want to make sure you are not running it over. Hence you can trade them even if you trade “part” time, you can even have “set it and forget it” trade, (not that I would ever recommend forgetting about your investments and trades!)
4. You can also use them for hedging for example in your retirement portfolio, this is key! Even if you may not decide to trade them actively there may be times when you will decide that you need and want to protect your portfolio. Options come in handy and using options will allow you to keep your position on and not being forced to sell it and therefore suffer some tax consequences.
5. Can be combined with stock to increase the yield of your position using strategies such as covered calls or derivatives
6. Can be used to enter positions at prices below the current market. A rather straightforward strategy that I will cover in a future posting will go in more detail about how you can do just this.
7. With options you can decide trade stock moves in any timeframe of interest to you (from weeklies to LEAPs). In fact there are some indices that have multiple expiration every week. Options can even be traded intraday with various account types therefore day trading options can be a safer alternative for small account that cannot purchase large amount of stock or ETF.
8. Even if you decide not to trade they can be used to gauge the sentiment of the other market players. Very often I watch the Implied Volatility, the Open Interest and Volumes traded for puts and calls for various indices or for specific stocks. The Implied Volatility and ratio of puts to calls is an “indicator” that is available to plot on many trading platforms and you can decide to use it when trading options or the underlying instrument.
9. A rather forgotten advantage of Options is they settle in one day (rather than 3 for stocks) and hence can be used more readily I small cash accounts
10. For the futures traders out there I want to remind you that there are options on futures that can be traded. I may come back to talk more about futures options at a later time since this is a more advanced topic
11. Trading options does not have to be exclusive; one can trade them in addition to your other trading instruments (futures, forex, stocks, ETFs...) or even in combination with them. Having the right broker that allows trading of options from the same account with the stock is very important. I may come back and discuss some option brokers in a later posting.
Now you may already be asking yourself why not everybody is trading options. Well first I should mention that more and more investors and traders are indeed adding options to their toolbox. But the one issue that I see from talking to many traders is the perceived complexity of the option and the complicated “lingo” that is being used by many professionals.
In general options can be explained in simple terms and taking the time to understand how to trade them will pay off in the long run. The fact is that at TTI we are providing personalized and in depth education and mentor-ship in the area of trading options.
Let me emphasize this: at the Trader Institute we take your trading education seriously! We offer multiple sessions of live sessions every day (in futures, forex, CFDs and options) and we also have educational evening sessions where we cover a lot of the issues that come up during the day and we also prepare for next trading session.
I know this is a lot to absorb if you are a beginning trader but if you have any questions or comments about this article or have any other question or comments about this topic please do not hesitate to contact me directly: Eugen@TheTraderInsititute.comWritten by- Eugen